30056

European Economic Policy

EU Single Market
 Contents: 13,19, 30-

1. The ingredients of the European Single Market (ESM)

2. Three steps (and counting) for the creation of the ESM
poseban
3. The peculiar case of services liberalization
4. The economic rationale of the single market
obrazlozenje

5. Growth effect of EU accessions

 Setup of the single market
With the Treaty of Rome (1957), the member States decided:
• to remove trade barriers between them,
• to set up a Customs Union (1968),
• to start the process of forming a Single Market (or common market).

In a single market, economic frontiers between member States are

eliminated and the so-called four fundamental freedoms (i.e. free
circulation of people, services, capital and goods) would be guaranteed.
What does ‘single market’ mean?
• A market has got its distinct geography due to restrictions of different
nature: physical (oceans, mountains ..), economic (transaction and
transportation costs), legal (exclusive rights, tariffs, standards ..).
• Market integration is a situation such that the flows of products,
services and factors between countries are on the same terms and
conditions as within countries.
• This creates new opportunities for businesses, but also gives
consumers wider choice and lower prices.
• In the single market price differences eventually arising among
countries should be no more than the cost of transportation plus
related transaction costs.
 The recipe for a single market
In order to change the geographic dimension of the market (i.e. from national markets
to a single market), States have to facilitate free circulation of goods, services, capital
and labour by: In the EU:
1) abolishing legal restrictions: no tariffs, no quantitative
European Single market
restrictions (quotas), no legal monopolies.

2) promoting fairness in free trade: no public subsidies and

protections granted in the domestic market to national Competition policy
players or anti-competitive behaviours by national players.

3) reducing the impact of physical obstacles: building or Trans-European Networks

upgrading transport infrastructure.

4) reducing economic costs: fixing exchange rates between Economic and Monetary
currencies, substituting national currencies with a single Union (EMU)
currency.
 Implementing the single market
In order to maximise the gains from market integration, two dimensions of
potential costs/distortions have to be eliminated, namely:

1. Market fragmentation caused by:

a. Non-tariff barriers (NTBs)
b. The absence of a regulatory framework

2. Negative macroeconomic spillovers

efekti
Keywords of the European Single Market
• Four fundamental freedoms. In the Treaty of Rome, the EU has the aim to achieve
free movement of goods, capital, services, and labour.
• Level-playing field. A market based on free and fair competition where everyone,
independently of the nationality, has the same chance of succeeding.
• Liberalization. It is the process of removing government control, reducing entry
barriers (e.g. authorizations and licenses) and opening up the markets to competition.
• Ownership neutrality. Usually liberalization goes with privatization (i.e. the transfer of
ownership from the government to the private sector). However in the EU, according to the
principle of ownership neutrality, State-Owned Enterprises (SOEs) are not illegal.
However SOEs, as any other firm, cannot receive a preferential treatment by any
public institution.
Examples: The French State is the main owner of Renault (15.01%); 20% of the votes in
Volkswagen are in hands of the State of Lower Saxony State and the Italian State is the main
owner of ENI (30.1%).
First step: elimination of tariffs and quotas

Starting from the late 1960s the EU abolished intra-EU tariffs and quotas
Second step: elimination of NTBs
• Elimination of tariffs and quotas is not enough if Non-Tariff Barriers (NTBs) keep
markets fragmented thus prevent the creation of a workable Single Market.
• NTBs might be imposed by countries to norm industrial production methods,
standards for safety, environment, consumer protection such as: Sanitary and
phytosanitary measures and Technical measures (eg, labelling)
• With the Treaty of Rome, the EU started a programme for the approximation of
Member States’ national legislations through directives and regulations.
• However, the progress in this area have been very limited, due to the
application of the unanimity voting rule in the Council of the EU (i.e., every
jednoglasnog glasanja
Member State has the veto power) on all issues related to the single market.
• Problem: the innovation is faster than the political decision-making, especially
when every country would like to propose its national standard as the European
standard..
 NTBs according to the Court of Justice
A watershed moment was in 1979 with the “Cassis de Dijon” case …

• Crème de cassis (also known as Cassis liqueur) is a sweet, dark red

liqueur made from blackcurrants.
• A German company requested authorisation from the German
administration for spirits to import Cassis into Germany from France.
• The response was that Cassis could not be marketed in Germany as
there was a national rule which required fruit liqueur to have at least
25% alcohol content (Cassis is between 15% and 20%).
• The German company then brought proceedings against that decision
in the national courts and the national courts referred to the CJEU for
further guidance.
NTBs according to the Court of Justice
• CJEU, in the “Cassis de Dijon” judgement, established the principle of mutual
recognition of national rules.
• This principle means that the legislation of another member State is
equivalent in its effects to domestic legislation.
• In other words, every member State is obliged to accept on its territory
products which are legally produced and marketed in another member State.
• This helped in eliminating the negative impact of most NTBs in place.
• However, the principle of mutual recognition is not enough to liberalize
economic activities within the European Single Market … a certain degree of
harmonization of legislation is required.
Third step: harmonization of legislation
• Many services are non-tradable (e.g. local transport, retail banking, mobile
telecommunication); this means that foreign firms cannot ship the service from
their home country but they need to locate assets in the target country.
• National regulations can block or can slow-down the entry of foreign firms. For
example:
– being a dentist in Italy requires a certification issued by an Italian authority.
– an airport in Germany allows only German airlines to land and take-off.
– different rules to operate as a mobile telecom firm in different EU states.
• a common regulatory framework has to be in place to guarantee the right of
establishment, i.e. the possibility for every national of a member State to
exercise its own economic activity in another member State.
?
• Moreover, the EU wants to set common essential health, safety, and
environmental protection requirements. Only if manufacturers follow these
common rules, their products can be sold freely in the European market.
• ‘Common’ means: harmonization of legislation.
 Third step: harmonization of legislation
zavrsetak
• In 1985 the Commission identified 282 regulations and directives to boost the completion of the
Single Market by dismantling
uklanjanjem
two main categories of obstacles:
• cost-increasing barriers: (e.g. delays at borders, customs administration, or the need to
comply with different national technical regulation and standards);
• market entry restrictions: all measures preventing the right of establishment or trading
across frontiers
granica
in certain service industries (e.g. insurance or electricity) or professions, or
the entry in some regulated markets (e.g. civil aviation, public procurement).
olaksa izmenile
• To facilitate the approval of the proposed regulations and directives, Member States amended
the Treaty of Rome with the Single European Act (SEA) entered into force in 1987.
• With the SEA, for single market legislation, Member States abandoned unanimity and adopted
qualified majority voting in the Council: with a majority system instead of unanimity, decision-
making is more efficient and member States lose the individual veto power.
Unanimity is still required for measures relating to fiscal provisions, freedom of movement for persons and
the rights and interests of workers.
• Those 282 directives and regulations were approved by 1992.
 The institutional design - nowadays
• At the same time, a Council Resolution of 1985 implemented a new system for
technical harmonisation and standardisation.
• The harmonisation directives would, from then on, focus on the essential
demands of health, safety and environmental protection at the European level
(general principles)
je tada prepusteno specijalizovanim telima

• Defining technical standards is left since then to specialised bodies such as CEN
(European Committee for Standardisation), CENELEC (European Committee for
Electrotechnical Standardisation) and ETSI (European Telecommunications
Standards Institute), and other specialised Committees eventually set up at this
purpose.
• From here on comitology started to emerge, as another important part of the
decision-making process of the EU.
 Liberalisation of services: the proposal
sprovesti
• During the 90s the EU liberalised big service sectors such as civil
aviation, telecommunication, energy (before that liberalization it was
common to have national monopolies or oligopolies protected by
national governments).
• The approach for those services was ‘vertical’, i.e. sector specific
legislation (regulations and directives).
• In 2004, the Commission proposed an ‘horizontal’ directive to liberalise
other services in the ESM such as:
management consultancy, certification and testing, facilities management
(including office maintenance and security), advertising, recruitment services,
legal and fiscal advice, real estate services, the organisation of trade fairs, car
Frits Bolkestein
rental, travel agencies, health care services, household support services,
European Commissioner for
tourism, audio-visual services, leisure services, sports centres and amusement
Internal Market from 1999
parks.
until 2004 during Romano
Prodi’s Presidency. • The aim of liberalization? Again, to facilitate cross-border activity within
the ESM.
Liberalisation of services: the proposal
uskladjenog pravnog okvira
• Absent an harmonized legal framework for those services, the
Commission proposed the application of the ‘country of origin principle’:
a service provider is subject only to the law of the country in which she is
established and other Member States may not restrict services she
provides.
• Surprise surprise, the idea of the Commission is not far from the principle
of mutual recognition (do you remember the “Cassis de Dijon” case?).
• Were the directive approved, a dentist who is legally practicing in Poland,
can offer her services in Germany subject to the Polish legal framework
(e.g. taxation).
• Don’t forget, proposed directives need to be approved by the Council and
by the European Parliament (EP).
• The Commission’s proposal was labelled (especially by French and
German socialists) as “ultra-liberal” and the country of origin principle
was an invitation to “social dumping”, in which competition from poorer
EU countries would drive down wages and welfare standards.
Liberalisation of services: the Directive
• After that ‘icy’ reaction, the European Commission modified its proposal
eliminating the ‘country of origin principle’ and reducing the range of
services covered.
• In 2006 the Council and the EP approved the modified ‘Service Directive’.
• Now, according to the approved Directive, a dentist who is legally practicing in
Poland, can offer her services in Germany only after she gets an authorization
by German authorities (if needed) and she will be subject to the German legal
framework … and German taxes.
• So today, if you produce a car in Poland with Polish workers, paying Polish
salaries, paying Polish services (e.g. electricity) and Polish taxes, you can sell
it in Germany without any type of restriction.
• But if you want to sell your Polish service as a dentist in Germany, you need
to pay German taxes.
• Or, you can invite your German patients to drive a few kilometers and provide
the full package (link 1, link 2)
A ‘soft’ liberalisation of services with the Directive
• With the new ‘Bolkestein’ Directive, Member States have to be more ‘business
friendly’ by simplifying procedures (eg, setting up points of single contact to enable
businesses access to information and complete all procedures), by abolishing
discriminatory requirements (eg, nationality or residence requirements) and other
restrictive measures.
• However, there are still national rules on professions across the EU, and they tend to
have restrictive effects on the cross-border activity.
• One common type of restriction is national rules that require a qualification/
certificate to be obtained in that specific State, without taking due account of service
providers' qualifications/certificates already obtained in other Member States.
• In 2005 the EU introduced a system of automatic recognition of professional
qualifications for nurses, midwives, doctors, dentists, pharmacists, architects and
veterinary surgeons.
• In 2006 the EU introduced the European Professional Card (EPC) for general care
nurses, physiotherapists, pharmacists, real estate agents and mountain guides.
 Online services and geo-blocking ?
Geo-blocking happens when online sellers/providers restrict online cross-border
sales based on nationality, residence or place of establishment.

In 2018 the EU adopted a regulation to ban unjustified geo-blocking in the internal market.
For example, now:
• A Belgian customer wishes to buy a refrigerator and finds the best deal on a German website. The
customer will be entitled to order the product and collect it at the trader's premises or organise
delivery himself to his home.
• A Bulgarian entrepreneur wishes to buy hosting services for her website from a Spanish company.
She will now have access to the service, can register and buy this service without having to pay
additional fees compared to a Spanish consumer.
• An Irish family wishes to visit a French theme park taking advantage of a family discount on the
price of the entry tickets. The discounted price should be available for the Irish family, just as it is
for French families.
Services where the main feature is the provision of access to and use of copyright protected
content, such as music, films, e-books, online games and software, are excluded from the
scope of the regulation.
 daje rezultate

Is the single market delivering?

• The Community legislation governing the setup of the single market is largely in the form
of directives (framework laws).
• But directives require the adaptation of the national legislation via transposition measures
from the EU framework law to the national laws.
• This transposition has not been straightforward, leading to delays in the implementation
of the single market or an uneven playing field.
• For these reasons, on the one hand the EC regularly monitors the extent of the
transposition deficit, forcing non-complying countries to accelerate in the implementation
of EU legislation (via fines that could be imposed by the Court of Justice)
• On the other hand, the most controversial legislation (e.g. new rules on banking) takes the
form of regulation, as these are directly enforceable in each Member State to the letter,
from the moment they are published on the Official Journal of the European Union
(OJEU).
 Is the single market delivering?

To calculate the transposition deficit of each Member State, the Commission includes:
• directives for which no transposition measures have been communicated
• directives considered to be partially transposed by Member State after it notified some transposition measures
• directives considered to be completely transposed by Member State, but for which the Commission has opened an
infringement proceeding for non-communication and the Member State has not notified new transposition measures after
the latest procedural step taken by the Commission
 obrazlozenje
The economic rationale of the single market
proizilaze
Static gains derive from improved
allocative efficiency within a wider
area: reallocation of resources
boosting overall per capita GDP.
Do you remember the Customs
Union model with economies of
scale?
Growth effects (also called “dynamic
gains”) derive from increased rates in
the accumulation of the factors of
production, in particular capital
(physical and human).
We will use Solow’s growth model to
explain it.
 Static gains
If competition is effective, the ESM:
• reduces barriers and costs of cross-border economic activities;
• allows economic agents (firms and consumers) to do business with the most
efficient partners (customer/supplier) in a wider area;
• selects the European ‘winners’ i.e. the efficient firms that can now serve a wider
market and can take advantage of economies of scale.
Economies of scale means: the larger the quantity produced, the lower the average
cost, thus lower prices for consumers!
But the ESM gives an opportunity to the losers.
• Thanks to liberalization, workers and capital employed in inefficient firms can move
to another sector (within the same country),
• Thanks to free circulation of workers and capital, they can move to another EU
country.
• EU rules for State aids allows governments to support the competitiveness of firms
under special circumstances and with conditions attached.
Dynamic gains with Solow’s growth model
The production function we are about to use is the Growth Model proposed by
Robert Solow (1987 Nobel Prize).
Basic assumptions:
• GDP (output) has three basic sources: Labor (L), Capital (K) and Total factor
productivity (TFP).
• Annual output is either consumed or saved in fixed proportions.
• Closed economy, thus no trade.
• Full employment.
• Since TFP is calculated as a residual (the portion of GDP that is not explained by
Capital and Labor), this model is dubbed “exogenous growth model”.
• Decreasing marginal product of both capital and labor. This occurs when one factor
is variable (e.g. labor) and one factor is fixed (e.g. capital).
 Dynamic gains with Solow’s model

Depreciation in a function
of capital = D

Savings are a function of GDP =

Gross investment (I)

As long as I > D, new capital When I = D (in A), savings are used to maintained
for the domestic economy. the capital already invested. No extra for new net
investment, no increase in capital, thus the
economy is in steady-state.
 Dynamic gains in the medium-term
= f’ (K/L)

= f (K/L)

>>>
Allocation effect
is a static gain
 Dynamic gains in the medium-term
• Integration improves the efficiency of the European economy by encouraging a
more efficient allocation of resources: this static gain (allocation effect) shifts the
GDP/L curve, i.e. there is an upward shift in the underlying production function,
from f to f’ (more output per worker is produced for any given K/L ratio)
• The shift up in the GDP/L curve also shifts up the investment curve since the fixed
investment rate now applies to higher output and so generates a higher inflow of
investment for any given K/L ratio.
• Schematically: integration → improved efficiency → higher GDP/L → higher
investment-per-worker → economy’s K/L ratio starts to rise towards new, higher
equilibrium value → faster growth of output per worker during the transition from
the old to the new K/L ratio.
• This is the so-called medium-run growth bonus from European integration.
 Dynamic gains in the medium-term
If also the efficiency of the financial sector improves, the marginal productivity of capital might rise
and thus more capital per unit of output is brought to the market. This yields a higher investment
rate: s’ > s thus generating additional growth.

’ = f’ (K/L)
G

E
’
F
’

D
 Towards a capital market union
• The efficiency of the financial sector can generate additional growth. However, the financial
sector in the EU is far from being a single market.
• Even though free circulation of capital is one of the four pillars of the common market since
1958, there are some obstacles to cross-border transactions that keep markets fragmented along
national borders.
• Relevant rules (eg, company law, securities law, insolvency procedures, access to collateral)
differ across EU States: less competition, no economies of scale, less efficiency!
• Moreover, high bank dependency in the EU. If we consider firms’ liabilities, bank loans weight for 14%
in the EU and 3% in the U.S. while corporate bonds weight respectively 4% and 11%.
• High bank dependency means that firms, in particular the small ones, have difficulties accessing
alternative funding sources when they cannot get credit from banks. And, since the financial crisis
(2008), cross-border lending in the EU declined and banking activities migrated increasingly back
to home jurisdictions.
• Along with other factors, this explain why, notwithstanding its economic size, the EU’s financial
system has not reached the dynamism of the American one (there are very few European Apples,
Amazons, Googles and Teslas …)
 Towards a capital market union
• The Commission launched a capital markets union (CMU) initiative in 2015 but markets
remained fragmented. The Commission re-launched the CMU in September 2020.
• Why now? A strong and complete CMU is needed now more than ever, in order to support the
economic recovery following the COVID-19 crisis and finance the green and digital transitions.
• The CMU action plan proposes 16 actions such as:
• Action 1: Making companies more visible to cross-border investors: Establishing a European
single access point (ESAP) to provide for seamless, EU-wide access to all relevant
information (including financial and sustainability-related information) disclosed to the
public by companies including financial companies.
• Action 2: Supporting access to public markets: Making listing cool again.
• Action 7: Empowering citizens through financial literacy.
• Action 14: Consolidated tape to provide complete, accurate and comparable data on prices
and volume of traded securities in the EU, thereby improving overall price transparency
across trading (and competition between) venues such as stock exchanges.
Medium-term growth effects: EU accessions
Accession countries provide a natural experiment to evaluate the medium-
term growth effects of European integration since these countries
experienced a rather sudden and well-defined increase in economic
integration when they joined.

1. stock market prices should increase (due to higher efficiency, thus profits
and expected dividends);
2. the aggregate investment to GDP ratio should rise;
3. the net direct investment figures should improve.
Medium-term growth effects: EU accessions (2)
Spain and Portugal (1986):
Medium-term growth effects: EU accessions (3)
The Baltic States (2004):
Medium-term growth effects: EU accessions (4)
Greece (1981, sharp contrast with other accessions):
 Long-run growth effects
• Can economic integration lead to permanently higher growth rates?
‘Qualified’ Yes:
➢ If the rate of technological progress is positively affected by market integration
➢ If tough competition as induced by the closer integration of the single market
leads to continuous productivity gains
➢ If structural reforms boost the potential growth of the involved countries

Any empirical evidence? Baldwin (1989) estimated a permanent 0.5% extra-growth per
year. The EU Commission (1996) estimated a permanent 1% extra-growth per year.